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The past week provided clear lessons not just in how central
bankers have a limited ability to positively influence the
economy but also how they are limited in their capacity to
deliver the shortsighted policy actions that investors currently
crave. The developments should provide new reasons for investors
and economy watchers to abandon their faith in central bankers as
super heroes capable of saving the economy.

The employment report released on Friday confirmed that the U.S.
economy is stagnating at best and actively deteriorating at
worst. While the numbers of jobs created in July was actually
better than many economists expected, it was still far below the
levels that would indicate a growing economy. But more
important than the official unemployment rate (which ticked up to
8.3%) or the number of jobs created, is the number of people who
have left the workforce out of frustration or despair. This
number continues to head higher. The labor force participation
rate, which is the percentage of healthy working age Americans
who actually have jobs, is at one of the lowest points since
women first started working en masse in the 1970’s. It’s
also instructive to add back into the unemployment rate those who
want full time jobs but who have had to settle for part time
work. This figure, reported under the “U6” category, currently
stands at 15.0%. This is just a 12% decline from the 17.1% high
seen December 2009. In contrast the “official” (U3)
unemployment figure has declined 17% from its peak.

In explaining these bad results, most economists simply look at
the stimulating effects of monetary and fiscal policy, not at the
problems that those measures create. As a result, it is assumed
that not enough stimulation, in the form of quantitative easing
or federal deficit spending, has been applied to the economy. The
next logical assumption is that if the measures of the past few
years had not been applied, we would have seen much weaker
results over that time. In other words, no matter how bad things
are now, defenders of the status quo will always describe how bad
things “could have been” if the Fed hadn’t stepped in. This
counterfactual argument gets increasingly threadbare as the years
wear on.

Rather than admit that its policies have failed, the Fed
statement last week gave all indications that it will continue
with its current inflationary policy to the bitter end. These are
the same errors that inflated the stock and real estate bubbles
and ultimately resulted in the 2008 financial crisis and our
continuing economic malaise. Without any fresh ideas, Fed press
releases have become a Groundhog Day repetition of the same
pronouncements and diagnoses. Oddly, many market watchers are
frustrated that the Fed has not telegraphed that more stimulus is
forthcoming. While it should be obvious that our current
“recovery” is dependent on monetary support, it should be equally
plain that the Fed can’t actually admit that fragility without
spooking markets. To be clear, QE III is coming, but the markets
should not expect Bernanke to supply a precise timetable.

Without question, if the Fed had not stimulated the economy with
zero percent interest rates, two rounds of quantitative easing
and operation twist, the initial economic contraction would have
been sharper. But such short-term pain would have been
constructive. By not taking away the cheap-money punch bowl, the
Fed has delayed the pain and prolonged the party. But to what
end? So far all we have received is a tepid phony recovery that
has sown the seeds of its own destruction.

In contrast, real economic restructuring would have resulted if
the Fed had withdrawn its monetary props. This would have
paved the way for a robust, sustainable recovery. Instead, the
Fed helped numb the pain with unprecedented (and apparently
permanent) liquidity injections. Its actions merely exacerbate
the underlying imbalances that lie at the root of our structural
problems, and thus act as a barrier to a real recovery. So long
as the Fed fails to learn from its prior mistakes, the phony
recovery it has concocted will continue to fade until we find
ourselves in an even deeper recession thanthe one we experienced
in 2008.

Those who believe that artificially low interest rates are needed
now, fail to see the price that will be paid down the road. By
keeping rates too low, the Fed continues to lead an overly
indebted economy deeper into the financial abyss. However, its
ability to maintain rates at such low levels is not without
limits. Just as real estate prices could not stay high forever,
interest rates cannot stay low forever. When rates finally rise,
the extent of the economic damage will finally be revealed.

The sad fact is that no matter how impotent and dishonest Fed
officials become, their elected rivals on Capitol Hill (who
control the fiscal side of the equation) have become even less
significant. The complete lack of any political conviction
to take steps to confront our fiscal imbalances means that Ben
Bernanke and his cohorts are seen as the only cavalry capable of
riding to the rescue. But no matter how often they blow their
bugles, our economy will continue to deteriorate until we stop
waiting for a savior and instead fight the battle for prosperity
ourselves.

Peter Schiff's new book, The Real Crash: America’s Coming
Bankruptcy – How to Save Yourself and Your Country is now
available. Order
your copy today.

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